Q: What's the worst mistake you see small business people make, from your perspective?
A: In the business formation world, there’s tremendous pressure to compete on price. You see $99 (or less) incorporations everywhere. But the only way to make that economic is to offer singular solutions – one size fits all documents, written for the lowest common denominator.
To me, that does a tremendous disservice to the clients, especially new business owners or entrepreneurs who don’t have a lot of money and often don’t know what they don’t know. The lack of knowledge leaves them vulnerable.
For example, a few years ago something called an IRA LLC, or checkbook LLC became really popular. It was marketed as a way to access and self-direct pension money without having to wait for pension custodians to vet investments and cut checks. The structure calls for you to essentially invest your pension into an LLC and then operate that LLC as a non-compensated manager.
Along with that control, however, comes the responsibility to make sure all of your investment decisions are appropriate and you don’t run afoul of IRS guidelines, which are strict and unforgiving. A mistake could cause your entire pension to be disqualified, liquidated and taxed. And there are so many ways to make mistakes. Like putting a personal down-payment on a pension-funded investment. Buying an investment property for the wrong family member (some are disqualified persons, others aren’t). Or paying yourself for managing the business. Custodians bear no responsibility because you are the one in charge, and the one calling the shots.
You’d think folks would be terrified at setting one of these up on their own, yet I saw all kinds of D-I-Y kits out there for $100-200 or so, all playing on the idea of freedom and control while downplaying (or entirely ignoring) the risk. The best analogy I heard was “It’s like giving your 16 year-old the keys to the Porsche.”
Regular business is just the same. I see awful documents people have bought online all the time. Key language is often missing. I reviewed an agreement for a Series LLC (another new type of structure) the other day that was less than 10 pages long, and so poorly written it left the purchaser exposed to liability. I’ve seen agreements that were obviously pulled from a lawyer’s file, and still contain the original parties’ names, along with specific clauses that make no sense in any other context. Yet people are told they can rely on these ‘lawyer-prepared’ documents to keep them safe from liability. Yes, they were prepared by an attorney, but for someone else. There’s no guarantee that these packages will work for you.
So if I could tell new business owners just one thing, it would be this: When it comes to taxes and liability, mistakes can have real-world consequences. There is no D-I-Y substitute for good information and advice.
Megan Hughes is owner and founder of Business First Formations, an incorporation services firm in Reno, NV. Megan is a career paralegal and expert on business formation and asset protection, as well as the co-author of "Smart Business, Stupid Business."